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First Coast Wealth Advisors
(904) 824-4349
January 13th, 2016

Financial Beacon for January 2016

 

This month’s edition of the First Coast Financial Beacon e-Newsletter includes recent financial news and articles to help you navigate your retirement planning and wealth management goals. In January’s edition:

  • 2015 Recap and 2016 Outlook
    Well, 2015 is officially over. From an investment perspective, this year was a little like that New Year’s Eve party you go to where you’re hopeful … [CLICK TO CONTINUE READING]
  • Follow a forecaster? Or flip a coin?
    Do you have a favorite forecaster? If so, when is the last time you checked his or her track record? You probably should because research … [CLICK TO CONTINUE READING]
  • How do they get it so wrong?
    Most of us hate uncertainty. And it’s our dislike of uncertainty that keeps the weather man and economic forecasters employed. But when was … [CLICK TO CONTINUE READING]

And remember, whatever your financial goals are in life – a luxury lifestyle, leaving a legacy, or simply having financial security in retirement – it’s our job to help you achieve those goals. We’re more than your advisors; we’re your partners.

Sincerely,
The Team at First Coast Wealth Advisors

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2015 Recap and 2016 Outlook

Well, 2015 is officially over. From an investment perspective, this year was a little like that New Year’s Eve party you go to where you’re hopeful there will be a lot of interesting people but leave feeling slightly disappointed.  With the exception of a couple of fixed income categories, all major asset classes domestically and abroad were either flat or declined modestly for the year, with emerging markets and commodities seeing larger declines. This presented broadly diversified investors with modest portfolio declines for the year in line with the major indices. In short, there were few interesting people at the party.  Below you’ll see a short list of major asset class returns for the year:

Dow Jones -2.2%

S&P 500 (US large stocks) -0.7%

Bonds – Barclays Aggregate Index +0.5%

Russell 2000 (US Small Cap Stocks) -5.7%

Dow Jones Global Stock Index (ex-US) -6.6%

MSCI Emerging Mkts (small global) -16.9%

Commodities – Dow Jones Commodity Index -19.0%

Real Estate – S&P Global REIT Index -3.4%

With respect to domestic stock markets, we witnessed our first intra-year market decline across all asset categories since the Great Recession of 2008 – a fair run in terms of historical market cycles. Readers of our monthly commentaries will be quick to note we’ve been reminding folks of this for a few years now. Generally we see intra-year market corrections in the neighborhood of 10%-15% or so every three to four years, so in a sense we’ve been overdue. But it’s particularly disappointing when all other major classes around the globe decline as well.

We’ve reviewed a mountain of post mortem analyst reports on 2015. Thanks to the internet, many of them are available to readers on line, so we won’t waste a lot of time dissecting them here. But here is a recap of the major contributors and detractors to 2015 investment results.

The “Plow Horse” Economy continues to trudge along. Yes, the economy expanded, but at tepid rate. Economic growth should come in around 2.5% for the past year – not much different than 2014.

Bright spots included a brisk employment and labor market, real estate expansion, and the continued improvement of corporate balance sheets. In fact, companies in the US are as lean and productive as they’ve ever been and have more cash in the bank than any other time in history. The Fed finally raised rates, and the world didn’t end.

In terms of not so bright spots, there are several. Wage growth remains sluggish. Corporate earnings are slowing down. (These first two are related.) Manufacturing has declined even though technology and R&D are expanding. Instead of hiring more people and raising wages, companies are electing to bolster their balance sheets and buy back stock. However, now that we’ve approached full employment we wouldn’t be surprised to see wages start to accelerate.

So, if corporate America is so healthy, why isn’t that being reflected in markets? We believe the answer lies in Washington. Political paralysis is a major contributor to economic malaise. The following two charts are both instructive and depressing. They reflect the divergence of political ideologies in both the Senate and the House over the past few decades. In short, no one reaches across the aisle anymore for anything.

A house divided

Vote Ratings

We raise this issue for two reasons: First, companies are rational. They deploy resources where they feel they can achieve the best return for shareholders, and the political environment has a huge influence on that process. When the political and tax structure favor expanding the workforce and paying workers more, companies comply. Then they don’t, well, you get the point. The second reason we point this out is more obvious: 2016 is an election year. Come November, we suggest investors vote accordingly if they’d like to see the economic environment improve by selecting candidates that don’t reinforce and defend the above dismal stalemate.

On a global perspective, Europe is finally emerging from its post –recession deep freeze by taking a page from the US playbook. Quantitative easing – effectively flooding the market with liquidity to force interest rates lower – is now underway. European companies should begin to see the benefit in 2016, but the strength or weakness of the US dollar will influence returns there. US equities outperformed their European counterparts for the third consecutive year, but that pattern is showing signs of age as European shares now look more attractive based on current valuations. China’s breakneck growth pace came to a screeching halt in 2015 as the central government wrestles with having it’s cake (in the form of a communist regime) and eating it too (by expanding its capitalistic footprint). The slowdown reverberated through emerging markets and commodities, which both experienced double digit losses due to supply and demand imbalances.

Geopolitical risks accelerated with the alarming expansion of ISIS and acts of terrorism in both Europe and the US. Should you have any illusions of how complex this birds nest really is, the following chart provides a dizzying summary of who supports whom:

Political Rifts

Despite the still forming coalition to combat ISIS, the problems inherent in the Middle East will not resolve themselves in short order. Despite what your Facebook friends may say, there are no easy answers. We expect this story will continue to take center stage through the election cycle in November.

2016 Economic and Market Outlook

The vast majority of forward looking forecasts suggest that the economic themes in 2016 will not change much from 2015. The US economy should continue to expand at around 2.5%. Developed economies in Europe are forecast to expand at about 1.5%. Japan should grow at about 0.5%. And China is projected to grow at around 6%, down from 2015’s 7.5% expansion rate. In terms of how these forecasts translate into the investment markets, remember that market valuations are nothing more than forward looking expectations of economic health.  In short, analysts expect more of the same.  We’ve now witnessed two consecutive years of lackluster investment results in diversified portfolios. And 2016 may bring more of the same if these economic forecasts are correct. Over the past year or so, we have noted in our commentaries that analysts expect most major asset classes to underperform their historical averages for the near term. (They certainly have for the past two years.) The following chart reflects the Long Term Capital Market Assumptions (LTCMA) for various assets as compared to their historical results. Readers will note that – with the exception of Emerging Market equities, all asset classes are expected to underperform their historical averages in the near term.

LACMT Returns

Source: JP Morgan

While the Fed will continue to be a distraction, they have stated emphatically that they plan to raise rates gradually. Expect some short term noise around any rate bumps in 2016, but markets seem to have factored in this gradual approach already.

In light of all this information, what should long term investors do?

We think it’s important to acknowledge the natural tendency of investors to want to “do something” when they are presented with less than rosy forecasts. Typical reactions are to search for assets that can provide potentially better returns than they expect to get from their current portfolio. (For instance, “Should we load up on oil?”) Many times, this leads to unwelcome surprises as investors “stretch” for returns without realizing how much additional risk they are adding. Instead, we suggest investors adopt and embrace the following simple approach:

  1. Set your expectations that returns may remain muted for the short term foreseeable future, but note that forecasters are often wrong. In fact, when all experts agree, something else is highly likely to occur. On average, forecasters are right slightly less than 50% of the time. A coin toss.
  2. Stick to the plan. Your portfolio should be a servant to your long term plan, not the other way around. If you’re on track to accomplish your plan goals, why risk derailing the plan?
  3. Above all else, remain diversified. Chasing yesterday’s winners, concentrating investments in more volatile assets (like high yield), etc., are not investing strategies – they are speculation. And speculation is akin to gambling. It is imperative that investors remember the following: There are mountains of evidence proving conclusively that no one can predict which investments will do well next year and which ones will do poorly. As such, diversification is your best weapon. In times where markets tread water, the soothsayers and snake oil salesmen come out of the woodwork promising some special insight into the future. Ignore them.
  4. Remain patient. If you own a broadly diversified mix of assets, ask yourself the following question: “Has there ever been a 10-15 year period in history where owning exactly what I own today wouldn’t have met my expectations?” For properly positioned investors, we expect the answer is a resounding ”no”. Assuming you plan to be around for another 10-15 years at least, why then would you muck up the works by speculating? In short, don’t let your emotions dictate your investment policy. We’ve seen plenty of times in history where returns are muted for 3-4 year periods before they revert to their long term return expectations.

 

In the meantime, we continue to make active adjustments in managed portfolios. Our criteria for adjustments follow three simple assessments: First, can we locate tactical managers that have historically been able to add value when markets tread water? (An example would be locating fixed income managers who have performed well in rising rate environments.) Second, can we maintain a client’s current risk profile while adding these managers to their portfolio? Third, can we keep management expenses the same or lower them by adding these managers? (Lower expenses translate into better returns for investors.) When these criteria can be met, we make the necessary manager adjustments. Our objective is to consistently improve portfolio efficiency in accordance with your long term objectives.

In closing, the world is more complex than ever, but we remain resolute in our belief that diversified investors who have a long term plan will be rewarded for their patience over time. Please don’t hesitate to reach out to us with any questions you may have. We’re proud to serve as your trusted financial advisor and will remain vigilant and focused on helping your achieve your goals and objectives.  Happy New Year!

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Follow a forecaster? Or flip a coin?

By Sheldon P. McFarland

 

Do you have a favorite forecaster? If so, when is the last time you checked his or her track record? You probably should because research exists that shows professional forecasters are about as accurate, on average, as a coin flip.
Source: www.cxoadvisory.com/gurus/

Last Graph

The chart above is the result of an ongoing analysis of equity market experts and their forecasts—the so-called stock market gurus. Analysts collected data from market forecasters since 1998. They tracked and graded the forecasts made by dozens of popular gurus over the years. And the results aren’t good! The “experts” accurately predicted market directions only 48% of the time — about as accurate as a coin flip.

What is interesting is how quickly the accuracy rating fell below 50%. It took only 2 years and 200 predictions. Once the accuracy fell below 50 percent, it remained fairly stable for the rest of the period analyzed. It was so stable in fact, that the analysts didn’t see a need to continue the study. They felt the results were conclusive.

Why is it so hard to forecast the market? I believe it is because markets move in random and unpredictable ways.

The theory of random walks supports my belief. This theory starts with the assumption that markets are efficient. An efficient market is described as one with a large number of rational profit-maximizers actively competing and where information is freely available to all participants.

In an efficient market, competition among the many participants leads to a situation where actual prices of individual securities reflect the effects of all available information. The key is information. Most gurus have the same information, which probably explains why they tend to have similar forecasts or at least forecast the market to move in the same direction.

The dark side of this forecasting nonsense is the wealth destruction that results due to investors moving in and out of the market based on these predictions. So what do you do when the industry experts show less forecasting accuracy than a coin flip? Start flipping coins yourself? No, you stop trying to time markets. You have the courage that it takes to ignore economic forecasts from experts with very impressive credentials. Their logic is compelling and their rationale seems sound but don’t let that fool you into making an investment mistake.
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How do they get it so wrong?

By Sheldon McFarland

Most of us hate uncertainty. And it’s our dislike of uncertainty that keeps the weather man and economic forecasters employed. But when was the last time you checked your favorite forecaster’s track record before acting on his or her prognostication? Chances are never.

I believe much of the trust placed in professional forecasters is misplaced, especially when it comes to economic forecasts. I’m not alone. John Cochrane, a University of Chicago professor, describes economic forecasting as inaccurate and financial forecasting as next to useless.1 And he does clarify that his comments pertain to “real” forecasters as opposed to the “clowns” on TV.

Consider the following example. In December of 2013, The Wall Street Journal published the interest rate forecasts of 46 economists.2 All but one predicted that rates would be higher in 2014 — and the other one predicted that rates would be flat. Fast forward 12 months and all of the experts were wrong. Rates actually declined.

Unfortunately, forecast errors seem to be the norm among market prognosticators. The chart at the right shows the forecasts of 18 investment strate- gists and money managers — the so-called experts— for the price of oil at the end of 2014. As you can see in the chart the experts were all wrong and the closest forecast was almost double the current price. Only three of the forecasters predicted the direction right (i.e., that the price would decline), but most forecasts were so far off that I’m not quite sure how they stay employed.

These forecasts were part of a CNN Money survey taken at the end of 2013. The experts ranked several other market indicators and whiffed them all. It’s time to think twice before putting your faith in professional forecasts.

If you’re wondering why it’s so hard to accurately predict the movement of the markets it may be because market movements are random, or at least that is the idea behind the theory of random walks.

Random-walk theorists believe that markets are efficient. An efficient market is defined as a market with many participants and freely available information. Competition among the many intelligent participants leads to a situation where actual prices reflect the effects of all known information.

The key is information.

Most professional forecasters are all working with the same information, which results in them coming up with similar forecasts. In order to truly have an edge in making predictions, a forecaster must have information that isn’t available to other market participants. And that would violate our market efficiency assumption.

The dark side of forecasting is the wealth destruction that can result due to investors moving in and out of the market based on these predictions. So what do you do when the industry experts show less forecasting accuracy than a coin flip? Start flipping coins yourself? No, you stop trying to time markets. You have the courage that it takes to ignore economic forecasts from experts with very impressive credentials. Their logic is compelling and their rational seems sound but don’t let that fool you into making an investment mistake that may put at jeopardy your long-term investment goals.

1 – Cochrane, John H., In Defense of the Hedgehogs, CATO Unbound, July 15, 2011
2 – Reddy, Sudeep, Economists Split on Start of Fed Pullback, December 13, 2013

 

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First Coast Wealth Advisors • 400 North Ponce de Leon Boulevard  • St. Augustine, FL 32084
Securities and Advisory Services offered through Geneos Wealth Management. Member FINRA/SIPC.

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